Mutual-fund giants pay price of betrayal

But it's about more than money. Market timing debased the fund companies' currency with clients, the trust of people like you and me.

The Globe and Mail
December 17, 2004

Mutual-fund giants pay price of betrayal
Andrew Willis

When the mutual fund market-timing scandal broke, industry kingpin Ned Goodman took the stage at the Toronto Society of Financial Analysts annual forecast dinner and proclaimed it was much ado about nothing.

To the cheers of Bay Street's finest, the founder of the Dynamic fund family claimed the affair was a media creation, and an American problem. When the full story came out, Mr. Goodman predicted, there would be a "minuscule" impact on investors, and no big payday for the institutional types who might have been playing these games.

I wanted to believe, Ned. I wanted to hear yesterday that the market cops were handing out traffic tickets for minor violations. I never wanted to hear what came out, news of an unprecedented $157-million levy on four of our biggest mutual fund companies, and a record $41-million in fines for three big banks.

Because my mom owns mutual funds. Everyone's mom owns mutual funds.

These are the savings that must carry ordinary folks through their retirement years.

The fund managers, the dealers, all the well-paid individuals entrusted with Mom's money, they just couldn't be mucking about. Could they?

Yes, they could. Mr. Goodman's company wasn't involved, so maybe he didn't know. And maybe the crowd that cheered him was deep into the chardonnay, or didn't appreciate what was happening in the shadows of their industry. Because the scale of the betrayal is staggering, as are the penalties.

Market timing sees big investors take advantage of a loophole in the way mutual funds are priced across different time zones. It's occasionally possible for the pros to buy and sell funds with "stale prices" that don't reflect where markets have moved, but these rapid trades undermine returns for long-term investors. Everyone in the industry knows this is the case. So most fund families ban the practice.

But over a period of years, four of Canada's flagship mutual fund companies — AGF, AIC, CI and Investors Group — let a handful of pros flip in and out of their funds. The brokerage arms of three of our biggest banks — Bank of Montreal, Royal Bank and TD Bank — helped at least 15 institutions strike special arrangements to facilitate this traffic.

Bank of Montreal's BMO Nesbitt Burns even had one of its own people market timing, using the house's own money. A proprietary trader bet $400,000 to $10-million on each trade. The pro trader kept at it, and was allowed to keep at it, while his employer got 21 separate written warnings, pleas to cease and desist, from at least a dozen different fund companies.

End result: The regulators found 15 institutions made more than $300-million from market timing. The pros get to keep that cash. By any measure, it's an impressive score.

To their credit, many Canadian mutual fund companies turned down these trades. They told the pros to sod off, with the likes of TD Mutual Funds warning that running a market-timing strategy would have a "significant negative impact on the performance of the funds involved."

However, the four major companies did roll over. No, they didn't break the law. But the very smart people running these companies knew exactly what happens when they let the market-timers in. As the Ontario Securities Commission said yesterday: "There have been clear violations of the principles of fairness to clients."

So yesterday, some of the biggest players in Canadian markets promised to pay back an incredible $156.5-million to long-term investors, to the blue-collar crowd, to my mom, to make up for the white-collar crowd's breach of trust. That's not a minuscule amount. The next biggest regulatory levy in Canadian history is in the $20-million range.

But it's about more than money. Market timing debased the fund companies' currency with clients, the trust of people like you and me.

While AIC was telling the world to "Buy, hold, and prosper," in its marketing campaigns, it was allowing a handful of market pros to make $127-million in profits from flipping in and out of its funds. For its part, AIC made $3.1-million in management fees off the market-timing activity. Yesterday, AIC announced it would ante up $58.8-million to investors, the price of living up to what was supposed to be the corporate credo.

The settlement spotlights an amoral attitude among certain players on the Street. It's an attitude that says if there's no law forbidding an activity, and that activity earns us a profit, then it must be fine to do it, right?

Because the paper trail here is clear. Most money managers resolutely refused to allow the market-timers in the door, on the grounds that their activities would garner higher returns than long-term investors, which just wasn't fair. A few firms left the doors wide open, or took great pains to ensure that such trading could take place.

The last market-timing transactions took place in 2003. This won't happen again. Putting this sorry affair to rest cost the financial sector a record $197.3-million, and millions more in legal fees. Hopefully, a lesson has been learned.

Hopefully, the continued trust of the investing public will mean more in the future than making a few extra bucks off a get-rich-quick opportunity. Hopefully, folks realize that reputation is worth more than the returns generated by activities such as market timing. Because moms everywhere deserve better than this.

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